Ethiopia takes first steps on PE journey

Covid-19 is a major setback, but reforms should help attract investors.

At first glance, Ethiopia looks like a fund manager’s dream. The economy has expanded more than sevenfold since 2000, according to the International Monetary Fund. With consumer purchasing power increasing rapidly and vast investments in infrastructure fuelling the rise of manufacturing firms, the longer-term outlook looks rosy.

Yet despite the apparent potential of many Ethiopian businesses, private equity firms face major hurdles in the country. For a start, local businesses are “still relatively unaware of private equity”, according to Matt Davis, CEO of RENEW, an impact investment firm that finances SMEs in Ethiopia on behalf of the Impact Angel Network. Private equity investors often hold seemingly positive discussions with acquisition targets, says Davis, only to find that the owners “are still unclear about what private equity is and how it works”.

Perhaps the most fundamental problem is a severe lack of liquidity. “Capital is so scarce here, that those who do have capital are young businesses,” notes Ashenafi Alemu, co-founder of Zoscales Partners, an East Africa-focused fund manager. “Most businesses are not in an M&A phase. Companies that do have capital still see enormous opportunities within their own businesses – if they have capital, they grow. They’re not interested in buying other businesses and growing through M&A.”

Adopting specialist strategies

But a handful of firms have since launched funds that largely or wholly focus on Ethiopia. For Zoscales, which made its first investments from a $75 million fund in 2018, the key has been to keep tightly focused on a handful of sectors. Given there is a tiny pool of executives within each sector that have the experience to manage portfolio companies, the firm places great emphasis on building its industry networks and identifying promising leaders. “You can’t do that across 20 different industries,” Alemu points out.

Zoscales has five portfolio companies in Ethiopia and expects to complete seven deals in its first fund. It plans to continue focusing on consumer goods, healthcare and materials in its second fund. The aim, says Alemu, is to “do fewer deals … and do them really, really well”.

Prime minister Abiy Ahmed’s plans to liberalise sectors currently dominated by state-owned companies, including telecoms and financial services businesses, are piquing the interest of larger PE firms. Alemu anticipates “lots of opportunities” as these sectors open for investment over the next three to five years. Yet Ahmed faces powerful opposition to his agenda. Irmgard Erasmus, senior financial economist at NKC African Economics, warns that major reforms, such as the creation of a local stock exchange, are likely “to hit more roadblocks” and delay the promised benefits by years.

In the meantime, Erasmus expects Ethiopia to “endure severe economic pain”, at least until the end of 2021, as the ruptures caused by covid threaten the already tenuous supply of foreign exchange. Unsurprisingly, PE firms are exposed to the crisis. “Generally, things have slowed,” Davis says. “Investors that were raising capital are seeing their fundraising schedule extended.”

Even so, for those on the front line of Ethiopia’s nascent private equity industry, the pandemic does not change the calculation that the country represents an attractive bet. “We remain cautiously optimistic in the near term and bullish for the long term,” says Davis.